Arbitrage and convergence: Evidence from Mexican ADRs

This paper investigates the convergence between the prices of ADRs and Mexican traded shares using a sample of 21 dually listed shares. Since both markets have similar trading hours, standard arbitrage considerations should make persistent deviation from price parity rare. We use a STAR model, where the dynamics of convergence to price parity are influenced by the size of the deviation from price parity. Based on different tests, we select the ESTAR model. Deviations from price parity tend to die out quickly; for 14 out of 21 pairs it takes less than two days for the deviations from price parity to be reduced by half. The average half-life of a shock to price parity is 3.1 business days, while the median half-life is 1.1 business days. By allowing a non-linear adjustment process, the average half-life is reduced by more than 50% when compared to the standard linear arbitrage model. We find that several liquidity indicators are positively correlated to the speed of convergence to price parity.